A New Stimulus for the Economy

For almost all of 2010, the Democratic Party vainly attempted to enact a second stimulus. Early in the summer the House of Representatives passed a substantial list of spending items. The election of Republican Senator Scott Brown, however, destroyed Democratic mastery of the Senate. Democrats were forced to find the support of at least one Republican in the Senate to pass a second stimulus. They largely failed to do so. With the November thumping of Democrats, it looked like the idea of a secondary stimulus was done for.

Well, the stimulus is back from the dead. President Barack Obama’s tax cut deal with the Republican leadership will pump nearly 300 billion dollars of mostly tax cuts into the economy. Remarkably, this stimulus is about twice the size of the one passed by the House this summer.

Now, the tax cuts being referred to here are not the Bush tax cuts. Extending all the Bush tax cuts does nothing more than continue the status quo; there is no stimulative effect. Rather, it is the other Republican concessions – the extension of unemployment benefits, the temporary payroll tax cut, and several other tax cuts in the original stimulus plan – which stimulate. The biggest by far is the temporary payroll tax cut.

This stimulus is far from perfect. It consists mainly of tax cuts, and it helps mainly the rich. A better stimulus would be spending-heavy and directed at the poor and middle-class. Spending is more effective than cutting taxes at stimulating the economy, and so is directing that stimulus at the poor (who will spend the money) rather than at the rich (who will save the money).

Nevertheless, 300 billion in stimulus is far better than nothing. Indeed, it is far better than almost all economists were expecting.

All of this is, of course, assuming that the fundamental philosophy which economic stimulus rests upon – Keynesian macroeconomic theory – actually works. Unfortunately, the real-life evidence is quite mixed.

Today the world is undergoing a great experiment. Some countries, notably in the European Union, are doing the exact opposite of what Keynes prescribes. Places like Great Britain and Spain are cutting spending in the middle of a recession. The United States is going down a completely different path: it is spending more in this recession. Mr. Obama’s tax-cut deal essentially doubles down on his belief in Keynesian spending.

Whether Mr. Keynes is right will determine the medium-term future of the American economy. It will certainly determine whether the president is re-elected.

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